Originally published in Canadian Tax Highlights, Volume 22, Number 9, September 2014. Reprinted with permission.

US estate tax return filing requirements surprise many Canadian executors. Often, the executor is in the throes of administering the estate when the lawyer or accountant sees a brokerage account statement and notices that the decedent had a sizable holding of shares of stock in a US corporation. The adviser informs the executor that because the decedent owned more than $60,000 of US stock, the executor must file a US estate tax return even though the shares are traded on the Toronto stock exchange and are owned in an RRSP. Moreover, the decedent was a lifelong Canadian citizen and resident and was never required to file a US income tax return during his or her lifetime.

The estate of each US resident and each US citizen must file a US estate tax return if the value of the decedent’s worldwide assets at death exceeds the estate tax exemption. The exemption increases annually for inflation and is $5.34 million in 2014. The estate of a non-US-resident non-US-citizen must also file a US estate tax return if the decedent owned more than $60,000 of US-situs assets. US-situs assets include real and tangible personal property physically located in the United States and shares in a US corporation.

Substantial relief is available under the Canada-US treaty, which allows the estate of a Canadian decedent to claim a prorated portion of the US estate tax exemption available to a US resident or citizen. Instead of being able to shelter only $60,000 of assets from estate tax, under the treaty a Canadian estate is allowed an exemption equal to that available to a US resident or citizen, multiplied by a fraction whose numerator is the decedent’s US-situs assets and whose denominator is the decedent’s worldwide  assets, wherever located. If the decedent was married, a treaty marital credit may also be available: in effect, the prorated estate tax exemption is doubled.

Even if no US estate tax is due after the application of treaty benefits, the Canadian estate must still file a US estate tax return if the value of the US-situs assets exceeds $60,000: filing a return is the only way to claim the treaty benefits. The return is due nine months after the decedent’s date of death, and an automatic six-month extension may be requested. If estate tax is due, an estimated tax payment should be submitted with the extension request in order to avoid interest and penalties for late payment of tax owed to the IRS.

Another important—and obscure—due date is the deadline for claiming the estate tax treaty marital credit. The treaty marital credit is available only if it is claimed on a US estate tax return filed by the deadline for making a US qualified domestic trust election—namely, one year after the estate tax return is due, including extensions. If the deadline is missed, the treaty marital credit evaporates; the result may be a substantial US estate tax bill in a situation where no tax was otherwise due.

Assembling the information needed for the estate tax return is a laborious task, and the executor and his or her advisers should leave themselves plenty of time to obtain the required information and valuations. In order to claim the prorated treaty exemption, the executor must value the decedent’s worldwide assets (the denominator in the prorating fraction); the assets must be valued using US estate tax principles, which requires specialized US tax knowledge. The worldwide assets include every item of property in which the decedent had any interest, such as bank accounts, real estate, stocks and bonds, life insurance, retirement accounts, and even jointly owned assets and some irrevocable trusts.

In many circumstances, proper lifetime planning may save the executor the cost and inconvenience of filing a US estate tax return; for larger estates, it may save the estate from paying a significant amount of US estate tax. If a person’s only US-situs assets are $61,000 of a US corporation’s stocks, selling those stocks prior to death—and eliminating the US estate tax return requirement—may be the answer. If an individual wants to purchase US real estate, the use of a properly structured trust as the purchase vehicle keeps the property from being included in his or her US estate. An adviser should warn the client that simply gifting US-situs assets to the beneficiaries during the client’s lifetime may create another problem:
no treaty relief is afforded for the US gift tax that may be triggered.